Thursday, September 25, 2008

There is a notion held by some on the right, that if government just would get out of the way then markets would function properly. That well function markets are the natural order and all government can do is mess them up with regulations. I disagree with this notion.

No, markets are like gardens. You have to intelligently design and fertilize them—with the right taxes, regulations, incentives, and disincentives—so they yield the good, healthy crops necessary for you to thrive.

I define well function market to mean one where the invisible hand is in effect and an individual pursuing his own self-interest will also promote the good of his community as a whole. While government over regulation can distort markets, under regulation can also cause markets to misfunction. The debate should not be about over regulation or under regulation, be whether if the regulations in place lead to a well functioning market.

Case in point is how to regulate the fishing market, so fishermen will maximize their own profits when they are also fishing safely and sustainably.

One such way to regulate fishing is for government to have a hands off policy and allow fishermen to take as much as they can. This leads to a tragedy of the commons scenario where fishermen invest in larger boats that can get as many fish as possible without regards for the future. The result is overfishing and collapse, as seen with the cod industry off of the Grand Banks.

A second way is for the government to set up catch limits and then close the fishing season as soon as those limits are hit. While this is better for sustainability, it makes fishing more dangerous as fishermen try and catch as many as they can in as few of days. There is also a big incentive for fishermen to try and catch more than they are allowed to.

A third way is for the government to set catch limits and privatize these rights (known as Individual Transferable Quotas (ITQs) or catch shares). Fishermen then own the right to a certain amount of the catch. A TED grant to the Environmental Defense Fund's Oceans Program allowed them to explore the impact of catch shares on the fishing market. Their results of their study was recently published in Science. The Economist looked at this study in twoarticles.

What was the impact of ITQs on sustainability and overfishing?

The overall finding was that fisheries that were managed with ITQs were half as likely to collapse as those that were not.

By giving fishermen a long-term interest in the health of the fishery, ITQs have transformed fishermen from rapacious predators into stewards and policemen of the resource. The tragedy of the commons is resolved when individuals own a defined (and guaranteed) share of a resource, a share that they can trade. This means that they can increase the amount of fish they catch not by using brute strength and fishing effort, but by buying additional shares or improving the fishery’s health and hence increasing its overall size.

In a report on this fishery, Dan Flavey, a fisherman himself, says some of his colleagues have even pushed for the quota to be reduced by 40%. “Most fishermen will now support cuts in quota because they feel guaranteed that in the future, when the stocks recover, they would be the ones to benefit,” he says.

Where mariners’ only thought was once to catch fish before the next man, they now want to catch fewer fish than they are allowed to—because conservation increases the value of the fishery and their share in it. The combined value of their quota has increased by 67%, to $492m.

By owning the right to the catch share, the fishermen have a financial incentive to see fish stocks increase, which aligns their interest with that of society as a whole. There is a notion held by some on the left that privatization of natural resources always leads to over exploitation. This study shows that privatization can actually lead to better sustainability.

What is the impact of ITQs on the fishing season, safety, the number of boats in the water and the profitability of the boats?

After a decade of using ITQs in the halibut fishery, the average fishing season now lasts for eight months. The number of search-and-rescue missions that are launched is down by more than 70% and deaths by 15%. And fish can be sold at the most lucrative time of year—and fresh, so that they fetch a better price.

With less gear in the water and less competition at specific times, individual boat yields rose by 75%.

ITQs allow for a longer season with less boats, more full time work and better profitability.

How are ITQs originally allocated?

In theory, for instance, you should allocate shares through auctions. But if fishermen do not agree to a new system, it will not work. So fishermen are typically just given their shares—which can lead to bitter, politicised arguments. In Australia, a pioneer in ITQs, a breakthrough came when independent allocation panels were set up to advise the fishing agencies, chaired by retired judges advised by fishing experts.

If fishermen are just given their shares, this is a government hand out to the fishermen. But, I would rather a few fishermen got unfairly rich than have a fishery collapse due to overfishing. Likewise, some might see it unfair that those that own the right can get rich as the value of the ITQ increases due to better management of the fishery (or that they can profit without even fishing, as a Alaskan crab ITQ owner can earn $243,600), but better that than the alternative.

As this example in fishing shows, it is the details of the regulations that determine how well the market functions. In this case, the fishing market functions best when the government takes the role of creating a catch share property right, allocating that right, determining the catch limit, and enforcing that limit (although other fishermen will now have an incentive to try and catch cheaters). If the government would "just get out of the way", the result would not be a better functioning market but rather a worse one. While over regulation can kill what makes markets valuable, so too can under regulation and wrong regulation.